State corporate income tax receipts have been shrinking over the last ten to fifteen years. Many corporations doing business in the U.S. are reducing their state taxes through a number of widely used tax evasion/avoidance schemes. These corporations may inappropriately reduce tax payments to states by maneuvering income, expenses, and assets solely for the purpose of cutting their taxes. These practices may be aided by major accounting firms and consultants who have developed successful strategies for assisting firms with “tax management,” a euphemism for tax avoidance schemes.
A major component of tax management involves organizations engaging in favorable transactions with commonly controlled entities. A commonly controlled entity need not be an incorporated entity or affiliated entity, but may be any entity that is controlled, directly or indirectly, by the same interests. Transactions with commonly controlled entities (controlled transactions) may be structured so that the tax burden on one or more of the parties is less than it would have been had the transaction not taken place or if the transaction had taken place at arms-length, between independent parties.
A lessened tax burden may be the result of favorable distributions of income, deductions, tax credits, or allowances stemming from a controlled transaction. This and other tax avoidance practices are known as “transfer pricing.” Transfer pricing is most commonly discussed on a federal scale for transactions that cross national borders. However, similar transactions between organizations in different states may alter the tax liability of one or more organizations in one or more states. These often complex transactions make it difficult for states to determine the tax liability of certain organizations.
When the Internal Revenue Service (IRS) believes that a U.S. subsidiary of a foreign company is not properly reporting its income in the U.S., an IRS economist's report adjusting the subsidiary's U.S. income may be issued to the taxpayer. The authority for this income adjustment is provided by U.S. Internal Revenue Code (IRC) Section 482. Regulations governing IRC Section 482 state, “The purpose of Internal Revenue Code Section 482 is to ensure that taxpayers clearly reflect income attributable to controlled transactions, and to prevent the avoidance of taxes with respect to such transactions.” The IRS adjusts entities' tax liability by re-allocating income, deductions, credits, or allowances based on what the allocation would have been if parties to a controlled transaction were independently controlled parties engaging in an arms-length transaction. This re-allocation may allow the transaction itself to occur and any non-tax benefits to accrue, while preventing any tax-avoiding consequences arising therefrom.
States can and have used authority similar to IRC Section 482 to augment state corporate taxable income or to reverse corporate actions taken solely for the purpose of reducing payment of state taxes. However, simply because state governments possess this power, their ability to effectively wield it is not guaranteed. States are not normally equipped to go up against large corporations who employ numerous accountants, economists, and consultants in attempts to reduce their tax liability. States may find even more difficulty when going up against numerous large corporations on an individual basis. These and other problems exist.
In view of the foregoing, it would be desirable to provide systems and methods for analyzing tax avoidance.